11 acronyms you need to know for income taxes

It’s that time of year. Again. And if working on your income taxes isn’t confusing enough, how about understanding the hodgepodge of letter combos that go with it?  

Here’s a handy reference to better understand some acronyms on those forms.

AGI – Adjusted Gross Income

Gross income is all the income you receive before taxes. (Examples: wages, business, or rental income.) AGI is your gross income minus certain tax-deductible expenses. Things like Individual Retirement Account deductions and Health Savings Account contributions, among others. Lowering your AGI through deductions makes your taxable income lower.

AMT – Alternative Minimum Tax

AMT is a different way to calculate federal income tax. It establishes a baseline for your tax rate and won’t let it go any lower. When you do your taxes, you’ll use the standard method and the AMT method, and then pay the higher of the 2 amounts (of course).

CTC – Child Tax Credit

The CTC can be claimed for all your qualified children under age 19 in a given tax year. This is a tax credit, not a tax deduction, meaning it reduces your taxes owed dollar-for-dollar. There are new rules about this in 2018, so be sure to read the IRS site (oops, another acronym—the Internal Revenue Service) about the CTC.

EIC or EITC -  Earned Income (Tax) Credit

This tax credit benefits working people who have a low or moderate income, meet certain requirements, and file a tax return. If you qualify, it reduces the amount of tax you owe (and may even give you a refund). The rules are a bit complex and they change every year, so learn more on the IRS site.

EIN – Employer Identification Number

This is a unique number assigned to a business, so it can be easily identified by the IRS. (Sometimes it’s called a Federal Tax ID number.) People have a unique Social Security number; this is the business equivalent of that. Where do you find the EIN? It’s a 9-digit number on your W-2 form, usually right above your employer’s name or below their address.

FICA – Federal Insurance Contributions Act

FICA is a federal law requiring employers to withhold a portion of an employee’s wages and pay it to a government trust fund for social services like Medicare and Social Security. You’ll see it on your pay stub and W-2 form.

HSA – Health Savings Account

An HSA is a tax-advantaged account for people who have a high-deductible health plan (HDHP) that allows you to save for out-of-pocket medical expenses not covered by your plan. You contribute on a tax-deductible basis, earnings can grow tax-free, and withdrawals are tax-free for qualified medical expenses. Of course, there are lots of rules (yes, more rules!) around HSAs, so visit the IRS website to learn more.

IRA – Individual Retirement Account (and it’s cousin, the Roth IRA)

A traditional IRA allows you to invest money for the long-term and pay taxes later. You may be able to deduct your contributions from your taxes in the year you contributed, depending on your income. You decide when to add money to your IRA and how it’s invested. Then when it’s time to withdraw your money in retirement, you’re taxed based on your income at that time, which might be lower.

With a Roth IRA, you pay taxes up front before you contribute to your account. Then your earnings can grow tax-free. You can withdraw your contributions penalty free. To withdraw earnings penalty-free, the funds need to be in the account for 5 years and you’ll need to be 59½.

MAGI – Modified Adjusted Gross Income

MAGI is used by the IRS to determine limits for different filing statuses. Basically, it helps to differentiate whether your tuition payments or IRA contributions are tax-deductible. To calculate MAGI, you add back things like half of your self-employment tax or deductions you’re taking for IRA contributions or student loan interest.

SEP IRA – Simplified Employee Pension IRA

A type of tax-deferred retirement plan that allows an employer to contribute to IRAs owned by its employees. (The employer can be you, if you’re self-employed.) The employer can change the amount each year but must contribute equally for all eligible employees. Contributions are typically not taxable to the participants until withdrawn, but they’re 100% vested immediately. See the IRS site for more information.

SIMPLE IRA – Savings Incentive Match Plans for Employees IRA

This simplified retirement plan gives employees the choice to make tax-deferred contributions, while requiring employers to make contributions if the company has 100 or fewer eligible employees. For the employer, contributions to a SIMPLE IRA may be federally tax deductible; for the employee, it may reduce taxable income.

Next steps

This subject matter is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment, or accounting obligations and requirements.